While 2017 and 2018 saw the rapid rise and fall of the ICO (Initial Coin Offering), 2019 and beyond may prove to be the era of a newer funding model — the STO (Security Token Offering). In this article, we take a brief look at STOs and how they differ from the traditional IPOs (Initial Public Offerings) in terms of regulation, landscape and outlook in the United States.
I. What is an IPO?
An IPO is one of the most traditional ways of raising capital from institutions and individuals. It does so by allowing a company to issue securities for the first time, which represent ownership in the company. To do this, there is an underwriting process and a set of regulatory steps that a company must go through. This involves, among other things, the creation of a prospectus, which includes information about the company such as its financial performance and future plans. The company also undergoes an audit of its financial statements before filing the IPO with the SEC (Securities and Exchange Commission) in the US.
Due to the number of moving parts, the process can often be expensive and time consuming. It is no wonder that many in the digital asset industry believe that blockchain and cryptoassets offer the potential for new funding models to improve upon the IPO.
II. What is an STO?
During the crypto bull run of 2017, many projects primarily issued utility tokens, which gave buyers access to a product or service instead of ownership. Based on comments from the SEC and the Howey Test, which is used to determine whether an asset is classified as a security, it remains unclear if ICOs did in fact manage to avoid the “security” designation.
Since then, a newer funding model has emerged which, from the outset, explicitly seeks to acknowledge the nature of the underlying digital asset as a security. STOs are providing a path to fractional ownership by enabling the tokenization of assets never before divisible. Since security tokens are backed by underlying assets or profits, investors gain access to equity, voting rights, and dividends. Security tokens can tokenize ownership in several forms such as:
Equity tokens: Representing ownership of equity in a company or entity.
Asset tokens: Representing physical ownership of an asset such as property.
Debt tokens: Representing ownership of debt e.g. bonds or mortgages.
III. Advantages of STOs
STOs offer several advantages over IPOs such as:
Speed: STOs cut out the need for a lot of the institutional middlemen, which means that issuers can offer their securities more quickly.
Lower Fees: Since less people are involved in the process, the fees associated with token issuance can be greatly reduced.
Security: Since security tokens are specifically designed to prevent fraudulent changes to records of prior transactions, the transactions are immutable.
Fractional Ownership: STOs allow companies to divide their assets into smaller units. This not only allows an easier transfer onto secondary markets, but also opens the offering up to more investors.
Greater Exposure: For many STOs, all that’s required to participate in an offering is an internet connection. Therefore, security tokens can reach a far broader and more international investor base.
IV. Regulatory Differences
STOs take advantage of several regulatory exemptions and updates to the Securities Act of 1933, which was designed to foster growth for small companies. These exemptions allow certain conditions for the issuance of securities without the usual registration process with the SEC. These include:
- Regulation A+: Following the JOBS Act of 2012, regulation A+ allowed eligible companies to raise up to $50 million in a 12-month period through accredited and non-accredited investors (retail investors) with an exemption from registration. However, this process can be long and costly.
- Regulation D: Allows companies to sell their securities without having to register with the SEC. Instead, by filling out form D after their first sale of securities, the company can meet the various required criteria. Yet in most scenarios, investors who buy securities in this way cannot sell them for at least 12 months after purchase.
- Regulation S: This exemption allows issuers to offer securities to non-US investors in offshore transactions without registration with the SEC. This is done to ensure no participant engages in directed selling efforts. Furthermore, STO issuers still have to abide by the securities laws in the foreign jurisdiction they are selling them in.
- Regulation CF: Allows some companies to raise up to $1.07M from both accredited and non-accredited investors.
2019 and Beyond
Many in the industry speculate that 2019 may prove to be the year for security tokens. Although the process involved in launching a security token is far more complex, as compared to ICOs, STOs can act as new and innovative means of raising capital in this era of greater scrutiny. Offering rights to underlying assets ranging from businesses to properties and art, the STO holds promise of a more responsible fundraising model that acknowledges its regulatory commitments from the outset — granting greater flexibility to, both, issuers and investors alike.
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